DRUM Community: Financehttp://hdl.handle.net/1903/22402015-08-02T18:23:49Z2015-08-02T18:23:49ZEssays on Asset Pricing and Financial StabilityLee, Jeongminhttp://hdl.handle.net/1903/158752014-10-17T02:31:16Z2014-01-01T00:00:00ZTitle: Essays on Asset Pricing and Financial Stability
Authors: Lee, Jeongmin
Abstract: My two-essay dissertation revolves around understanding the financial crisis of 2008. First I focus on the repo market, a major funding source of the shadow banking system, and show the repo market can create and amplify the fragility of the system. Then I investigate a broader economy with heterogeneous agents and demonstrate how the dynamics of equilibrium asset prices and wealth distributions are determined.
In Essay 1, I develop a dynamic model of collateral circulation in a repo market, where a continuum of institutions borrow from and lend to one another against illiquid collateral. The model emphasizes an important tradeoff. On one hand, easier collateral circulation makes repos liquid and increases steady state investment through several multiplier effects, improving economic efficiency. On the other hand, it can harm financial stability because less capital is sitting on the sidelines waiting for investment opportunities. This fragility is further exacerbated by the endogenous repo spread through a positive feedback loop, and can result in an inefficient repo run. The model is relevant for understanding the repo markets during the financial crisis of 2008.
In Essay 2, I study the dynamics of the wealth distribution and asset prices in a general equilibrium model. Agents face heterogeneous portfolio constraints that limit the shares of risky investments relative to wealth. The setup is motivated by empirical evidence that many households do not participate in the stock market and portfolio shares are heterogeneous and persistent conditional on stock market participation. There are two main results. First, one state variable can summarize the wealth distribution regardless of the number of types of agents. Second, when the economy is bad, it becomes more sensitive to additional negative shocks, meaning that not only magnitudes of the shocks but also their frequency matters.2014-01-01T00:00:00ZESSAYS ON MARKET MICROSTRUCTURE AND HIGH FREQUENCY TRADINGLi, Weihttp://hdl.handle.net/1903/158672014-10-17T02:30:47Z2014-01-01T00:00:00ZTitle: ESSAYS ON MARKET MICROSTRUCTURE AND HIGH FREQUENCY TRADING
Authors: Li, Wei
Abstract: This dissertation includes two chapters on topics related to market microstruc-
ture and high frequency trading.
In the first chapter, I explore the effects of speed differences among front-running high frequency traders (HFTs) in a model of one round of trading. Traders differ in speed and their speed differences matter. I model strategic interactions induced when HFTs have different speeds in an extended Kyle (1985) framework. HFTs are assumed to anticipate incoming orders and trade rapidly to exploit normal-speed traders' latencies. Upon observing a common noisy signal about the incoming order flow, faster HFTs react more quickly than slower HFTs. I find that these front-running HFTs effectively levy a tax on normal-speed traders, making markets less liquid and prices ultimately less informative. Such negative effects on market quality are more severe when HFTs have more heterogeneous speeds. Even when infinitely many HFTs compete, their negative effects in general do not vanish. I analyze policy proposals concerning HFTs and find that (1) lowering the frequency of trading reduces the negative impact of HFTs on market quality and (2) randomizing the sequence of order execution can degrade market quality when the randomizing interval is short. Consistent with empirical findings, a small number of HFTs can generate a large fraction of the trading volume and HFTs' profits depend on their speeds relative to other HFTs.
In the second chapter, I study the effects of higher trading frequency and front-running in a dynamic model. I find that a higher trading frequency improves the informativeness of prices and increases the trading losses of liquidity driven noise traders. When the trading frequency is finite, the existence of HFT front-runners hampers price efficiency and market liquidity. In the limit when trading frequency is infinitely high, however, information efficiency is unaffected by front-running HFTs and these HFTs make all profits from noise traders who do not smooth out their trades.2014-01-01T00:00:00ZSTRATEGIC DEFAULT, RENEGOTIATION, AND RECOURSE IN RESIDENTIAL MORTGAGE CONTRACTSSinha, Anshumanhttp://hdl.handle.net/1903/148352014-02-07T03:30:57Z2013-01-01T00:00:00ZTitle: STRATEGIC DEFAULT, RENEGOTIATION, AND RECOURSE IN RESIDENTIAL MORTGAGE CONTRACTS
Authors: Sinha, Anshuman
Abstract: In this article we model strategic default and renegotiation in residential mortgage contracts. In particular, we study how recourse affects mortgage rates and default. We find that in the presence of recourse, default rates are lower for a given loan-to-value ratio, equilibrium coupon rates are lower, loan-to-value ratios are higher and welfare is improved. We find that higher loan-to-value ratios under recourse, increase welfare but can lead to higher equilibrium default rates. We find that when the bank has monopoly power during renegotiation, contracts with renegotiation are an improvement over contracts without renegotiation. Increase
in homeowner renegotiation bargaining power, beyond a threshold, has a negative effect on equity value since the surplus that the homeowner can extract ex-post is priced into the initial mortgage rate. We show that the provision of recourse and the balance of bargaining power during renegotiation alleviates some of the distortions due to moral hazard implicit in debt contracts. Our equilibrium concept is sub-game perfect Nash and we derive closed form solutions in the model.2013-01-01T00:00:00ZEssays on Mutual FundsKumar, Nitinhttp://hdl.handle.net/1903/147652014-02-05T03:30:37Z2013-01-01T00:00:00ZTitle: Essays on Mutual Funds
Authors: Kumar, Nitin
Abstract: My dissertation comprises of three essays on mutual funds. In the first essay, I test whether fund investors rationally incorporate portfolio manager ownership disclosure in their portfolio allocation decisions. Using a natural experiment, regulations that mandate portfolio manager ownership disclosure, I find that investor flows respond to higher percentage ownership. The relationship between investor flows and percentage ownership is persistent well after the regulatory change in 2005, suggesting that the investor responses are permanent rather than transient and are robust to several controls as well as unobserved heterogeneity reflected in fund family and manager fixed-effects. The investor responses to ownership are rational, as investors investing in higher percentage ownership funds are rewarded back in terms of higher risk-adjusted performance. Finally, I shed light on the channels through which higher ownership translates into better investor rewards. I show that agency alleviation is one of the channels through which ownership translates into better investor rewards. These findings are consistent with a "rational investor" viewpoint in which, at least, some investors incorporate managerial ownership in their portfolio allocation decisions.
In the second essay, I analyze the "herding" (trading together) behavior of managers, conditional on their ownership stakes in the funds they manage. I find that the funds with low and high managerial ownership have economically distinct patterns in their herding behavior. Each herd has its own distinct trading style and different qualitative and quantitative effect on stock prices. Low ownership funds herd more and engage in positive-feedback trading that is followed by stock price reversals. High ownership fund herding is followed by more stable price adjustments. Low ownership herding effects appear to dominate in the full sample where herding causes price reversal. These findings suggest that there is heterogeneity in the herding behavior of mutual funds, which appears to be related with ownership. It is costly for the high ownership managers to ignore their substantive information due to reputational concerns, or to engage in uninformed trading, and thus herding by such managers results in more informative prices. On the other hand, lower ownership fund herding appears to be driven by agency that generates temporary price movements that are reversed.
In the third essay, I and my co-authors, Gerard Hoberg and N. R. Prabhala, propose new techniques for identifying benchmark peers for mutual funds. We identify the location of funds in the space of stock style characteristics. All funds within a pre-specified normed distance are a fund's peers. Our benchmark peers are customized to each fund, intransitive, and employ techniques that are readily scalable across dimensions and loss functions. We show that peers derived in this fashion are significantly different cross-sectionally from conventional peers and exhibit considerable dynamic churn. The customized peers we construct outperform traditional peers in out of sample prediction tests, have lower tracking error, and our peer-excess alphas predict the future Characteristic-Selectivity and Carhart alphas of funds. We find that measures of competition derived from our peers predict performance persistency of funds for up to four quarters.2013-01-01T00:00:00Z